Large-Cap Growth's Shrinking Feeling

Small companies are typically more nimble than their bigger brethren, which enables them to outperform during economic slumps as well as in turnarounds. They also benefit from the lower cost of capital, which makes it easier to expand.

Generally, large-cap stocks take the baton from smaller ones during the latter stages of a recovery, when rates start moving upward in earnest. This is why many large-cap growth fund managers place part of the blame for their funds' underperformance on the Fed and its measured stance toward rate hikes.

After all, fans note, large-cap growth stocks grabbed their glory during the late 1990s after a slew of Fed rate hikes in 1994 zapped small-caps into submission.

As Duncan Richardson, portfolio manager for the $3.7 billion, large-cap (ETTGX Quote)Eaton Vance Tax-Managed Growth fund, points out, the Russell 1000 Growth index outperformed the Russell 1000 Value index by an average of 7 percentage points from 1994 to 1999.

"They were firing value managers because they were only up 23%," notes Richardson.

Value managers should feel more secure in their jobs these days, though, as the spread has substantially reversed. Indeed, value leads growth by 11% per year since 2000. Year to date, the Russell 1000 Value index is up close to 15%, while the Russell 1000 Growth index has climbed just 5%.

Ironically, large-cap growth managers believe valuation is the central reason why their funds will gain traction in 2005. Alec MacMillan, portfolio manager for the $950 million (LEGAX Quote)Columbia Large-Cap Growth fund, says growth stocks typically trade at a 40% premium to value stocks, a gap that yawned as wide as 80% in 2000 just before the bubble popped.

MacMillan currently calculates the growth premium to be 35%, the lowest since 1980.

"It's rather simplistic to say, but we're due for some outperformance," says MacMillan, who is loading his fund with shares of electronics retailer Best Buy (BBY Quote) and medical device manufacturer Zimmer (ZMH Quote).